The change is marked to bring about a key legislation to make it easier for small businesses to monetize their receivables. The bill was tabled in September last year and was recently passed on 29th July, 2021. The amendment bill makes it easier for NBFCs to participate in the factoring business. It also removes the tedious requirement of an entity in this business to report factoring information within 30 days.
The 2011 Factoring Regulation Act allowed the Reserve Bank of India (RBI) to authorise NBFCs to remain in Factoring business only if that’s their main focus of the business and over 50% of their assets have been deployed and 50% of their revenue is earned from the factoring business. This bill aims at removing this threshold which will open new avenues in this business to more non-bank lenders at the current times of financial stress during the pandemic.
What is Factoring and why is it important?
Factoring is a transaction where the accounts receivables of an entity, known as the factor, is paid by another entity, known as the assignor. A factor can be a bank or an NBFC or any institution registered under the Companies Act. Factoring helps businesses to monetize its receivables quickly and tackle cash-flow problems conveniently and in time. This bill enables NBFCs and other companies to enter the factoring businesses and help small businesses survive during these difficult times. The move will help bring down the overall cost to acquire funds and empower small businesses to generate cashflows even at difficult times. The provision of liquidity to support MSMEs have been a key element of the government’s plans and policies to cushion the impact of the pandemic. Empowering the MSMEs is important because they are a major source of employment generation in the rural and urban areas.
Finance Minister Nirmala Sitharaman said, “Amending the Factoring Regulation Act, and changing the definition of “assignment”, “factoring business” and “receivables”, “will bring them in consonance with international definitions”, she further added, “The Bill seeks to provide a strong oversight mechanism for the factoring ecosystem, and will empower the Reserve Bank of India to make regulations with respect to factoring business”.
Currently due to the number of issues, the factoring credit constitutes only 2.6 percent of total formal SME credit finance in India. The estimate points out that only 10% of the receivable market is presently covered under the bill discounting system while the rest is covered under conventional cash credit overdraft arrangements with financial institutions. The delay in getting payments against their bills, the MSMEs struggle with working capital and it hampers with the efficient activity and functioning of the MSMEs and this bill aims to remedy just that.
Factoring and its growth in China
We already discussed factoring, but China adopted Factoring in a big way a decade ago and they are far ahead of the world as far as the number of MSMEs are concerned. They have adopted debtor financing where the company sells accounts receivables at a discount to clear current debts and seek capital for smooth functioning of the business. Banking and e-commerce sector has found this to be a sustainable business model across various industries.
Large companies, especially e-commerce, set up in-house financing or Factoring company as a subsidiary to fund and support thousands of small and medium enterprise clients, with huge amounts of receivables in the ledger. This dual layered model of factoring is called double factoring. Banks finance the subsidiaries which are a separate entity from the company being funded within the umbrella.
Double factoring helps suppliers meet their immediate credit and cash flow needs and increases the asset liquidity of the in-house factoring entities. The costs of funding reduces significantly from that of a bank and proves beneficial in the long run.
Factoring is an important step towards stabilizing the economy in current times. NBFCS can come to the aid of the cash-starved MSMEs and help them with their financing needs.
In the current environment where access to finance is critical to jumpstarting economic growth, the Factoring Regulation Bill may play a key role in bridging the gap and helping Indian businesses push forward into 2022.
In the past, in other countries, what we’ve seen is that a more liberalized approach to factoring takes the pressure off lending institutions – this means more access to capital for the businesses that need it. In the long term, the implications here are clear. The Factoring Regulation Bill isn’t just going to help businesses come out of the pandemic induced crisis situation. As we move into the next decade, the enhanced access to capital will help Indian businesses drive consistent economic growth.
(The writer is Co-founder, Cashinvoice)
Download The Economic Times News App to get Daily Market Updates & Live Business News.